<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___
---------------
Commission File Number 0-25457
NEON SYSTEMS, INC.
(Exact Name of Registrant as specified in its charter)
DELAWARE 76-0345839
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14100 SOUTHWEST FREEWAY, SUITE 500, SUGAR LAND, TEXAS 77478
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (281) 491-4200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The number of shares of the registrant's common stock outstanding as of February
10, 2000 was 8,978,579.
<PAGE> 2
NEON SYSTEMS, INC.
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at December 31, 1999 and March 31, 1999 ....... 3
Consolidated Statements of Operations for the Three and Nine Months
Ended December 31, 1999 and 1998 .......................................... 4
Consolidated Statements of Cash Flows for the Nine Months Ended
December 31, 1999 and 1998 ................................................ 5
Condensed Notes to Consolidated Financial Statements ...................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ..................................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................ 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ......................................................... 20
Item 2. Changes in Securities and Use of Proceeds ................................. 20
Item 3. Defaults Upon Senior Securities ........................................... 20
Item 4. Submission of Matters to a Vote of Security Holders ....................... 20
Item 5. Other Information ......................................................... 20
Item 6. Exhibits and Reports on Form 8-K .......................................... 20
SIGNATURES ......................................................................... 21
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, 1999 MARCH 31, 1999
------------------ ------------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash & cash equivalents $ 33,223,327 $ 45,400,015
Short-term investments 5,163,127 --
Accounts receivable-trade 8,657,155 5,438,319
Accounts receivable-related party 119,801 278,817
Deferred income taxes 704,053 571,990
Other current assets 645,264 410,620
------------------ ------------------
Total current assets 48,512,727 52,099,761
------------------ ------------------
Furniture & equipment 1,285,044 895,970
Purchased software 504,171 78,774
Less: accumulated depreciation and amortization (678,449) (487,670)
------------------ ------------------
Property & equipment, net 1,110,766 487,074
Marketable securities 3,005,703 --
Goodwill, net 2,268,529 --
Other assets, net 3,533,158 47,916
------------------ ------------------
Total assets $ 58,430,883 $ 52,634,751
================== ==================
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued expenses $ 921,563 $ 1,222,154
Accounts payable 1,720,724 1,474,763
Taxes payable 1,115,570 371,844
Deferred income taxes -- 27,897
Deferred maintenance revenue 5,208,605 3,707,997
------------------ ------------------
Total current liabilities 8,966,462 6,804,655
------------------ ------------------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value. Authorized 10,000,000
shares; no shares issued and outstanding -- --
Common stock, $.01 par value. Authorized 30,000,000
shares; 8,971,413 and 8,848,251 shares issued at
December 31, 1999 and March 31, 1999, respectively;
8,966,339 and 8,848,251 shares outstanding at
December 31, 1999 and March 31, 1999, respectively 89,714 88,483
Additional paid-in capital 45,937,927 46,174,124
Accumulated other comprehensive income 3,688 57,849
Unearned portion of deferred compensation (1,007,976) (1,710,371)
Retained earnings 4,581,554 1,220,011
Less treasury shares, at cost; 5,074 and -0- shares at
December 31, 1999 and March 31, 1999, respectively (140,486) --
------------------ ------------------
Total stockholders' equity 49,464,421 45,830,096
------------------ ------------------
Commitments and contingencies (Note 4)
Total liabilities and stockholders' equity $ 58,430,883 $ 52,634,751
================== ==================
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE> 4
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED DECEMBER 31, NINE MONTHS ENDED DECEMBER 31,
------------------------------- ------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
License $ 7,223,506 $ 4,543,462 $ 16,024,660 $ 10,541,224
Maintenance 1,695,223 1,306,494 5,039,200 3,293,622
------------ ------------ ------------ ------------
Total revenues 8,918,729 5,849,956 21,063,860 13,834,846
Cost of revenues:
Cost of licenses 693,856 134,381 1,104,108 661,515
Cost of maintenance 538,852 264,684 1,162,294 672,399
------------ ------------ ------------ ------------
Total cost of revenues 1,232,708 399,065 2,266,402 1,333,914
------------ ------------ ------------ ------------
Gross profit 7,686,021 5,450,891 18,797,458 12,500,932
Operating expenses:
Sales and marketing 3,139,883 2,071,374 7,951,237 5,317,752
Research and development 1,383,062 1,046,303 3,767,496 2,706,036
General and administrative 889,478 664,982 2,563,945 1,701,472
Non-cash compensation expense 457,720 136,337 730,397 630,944
Amortization of goodwill 116,765 -- 116,765 --
------------ ------------ ------------ ------------
Total operating expenses 5,986,908 3,918,996 15,129,840 10,356,204
------------ ------------ ------------ ------------
Operating income 1,699,113 1,531,895 3,667,618 2,144,728
Interest income 596,995 34,480 1,736,525 67,101
Interest expense (396) (20,983) (1,797) (63,687)
Other, net (41,476) 15,345 (66,564) 40,509
------------ ------------ ------------ ------------
Income before provision for
income taxes 2,254,236 1,560,737 5,335,782 2,188,651
Provision for income taxes 803,252 592,269 1,974,239 824,598
------------ ------------ ------------ ------------
Net income 1,450,984 968,468 3,361,543 1,364,053
Dividends on series A redeemable,
convertible preferred stock -- (25,000) -- (75,000)
------------ ------------ ------------ ------------
Net income applicable to common
stockholders $ 1,450,984 $ 943,468 $ 3,361,543 $ 1,289,053
============ ============ ============ ============
Earnings per share:
Basic $ 0.16 $ 0.36 $ 0.38 $ 0.49
============ ============ ============ ============
Diluted $ 0.14 $ 0.14 $ 0.32 $ 0.20
============ ============ ============ ============
Shares used in computing earnings per share:
Basic 8,949,989 2,659,214 8,890,762 2,607,587
Diluted 10,403,910 7,092,138 10,481,666 6,933,985
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE> 5
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED DECEMBER 31,
----------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,361,543 $ 1,364,053
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 190,779 141,182
Deferred tax expense (159,960) (186,624)
Non-cash compensation expense 730,397 630,944
Amortization of goodwill 116,765 --
Increase (decrease) in cash resulting
from changes in operating assets and liabilities:
Accounts receivable (2,997,399) (1,647,572)
Other current assets (234,644) 136,341
Other assets (3,485,242) (172,434)
Accrued expenses (1,238,375) (208,984)
Accounts payable 168,611 445,017
Taxes payable 743,726 131,222
Deferred maintenance revenue 1,383,618 1,030,053
--------------- ---------------
Net cash provided by (used in) operating activities: (1,420,181) 1,663,198
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (8,189,964) --
Acquisition (1,870,000) --
Purchases of furniture and equipment (183,915) (86,267)
Purchases of computer software (425,397) --
--------------- ---------------
Net cash used in investing activities (10,669,276) (86,267)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of stock options 86,282 144,279
Shares purchased for treasury (140,486) --
--------------- ---------------
Net cash provided by (used in) financing activities (54,204) 144,279
--------------- ---------------
Net increase (decrease) in cash and cash equivalents (12,143,661) 1,721,210
Effect of exchange rates on cash (33,027) (14,442)
Cash and cash equivalents at beginning of period 45,400,015 2,804,073
--------------- ---------------
Cash and cash equivalents at end of period $ 33,223,327 $ 4,510,841
=============== ===============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 1,395,147 $ 905,206
=============== ===============
Cash paid during the period for interest $ -- $ 83,928
=============== ===============
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE> 6
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
NEON Systems, Inc. and subsidiaries (collectively, "NEON") are comprised of
the parent company, NEON Systems, Inc., its wholly-owned subsidiary NEON Beyond
Acquisition Corporation and the parent company's wholly-owned international
subsidiaries, NEON Systems (UK) Ltd. and NEON Systems (GmbH). NEON develops,
markets and supports Enterprise Access and Integration software. NEON's primary
product family, Shadow, helps organizations access and integrate data,
transactions and applications from the Internet and mainframe and client/server
systems.
The condensed consolidated financial statements included herein have been
prepared by NEON without audit pursuant to the rules and regulations of the
Securities and Exchange Commission. The financial statements reflect
adjustments, consisting only of normal recurring accruals, which in the opinion
of management are necessary for a fair presentation of the financial position,
results of operations and cash flows for the interim periods presented. The
results of operations for the periods presented are not necessarily indicative
of the results to be expected for the full year. The accompanying unaudited
condensed financial statements should be read in conjunction with the financial
statements and notes included in NEON's Annual Report on Form 10-K for the
fiscal year ended March 31, 1999.
NOTE 2--PER SHARE INFORMATION
Per share information is based on the weighted average number of common
shares outstanding during each period for the basic computation and, if
dilutive, the weighted-average number of potential common shares resulting from
the assumed conversion of outstanding stock options and convertible preferred
stock for the diluted computation.
A reconciliation of the numerators and denominators of the basic and diluted
per share computation is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED DECEMBER 31, NINE MONTHS ENDED DECEMBER 31,
--------------------------------- ---------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net income $ 1,450,984 $ 968,468 $ 3,361,543 $ 1,364,053
Dividends on series A redeemable,
convertible preferred stock -- (25,000) -- (75,000)
--------------- --------------- --------------- ---------------
Net income applicable to common stockholders $ 1,450,984 $ 943,468 $ 3,361,543 $ 1,289,053
=============== =============== =============== ===============
Weighted average number of common
shares outstanding during the period:
Basic 8,949,989 2,659,214 8,890,762 2,607,587
Dilutive stock options 1,453,921 1,307,924 1,590,904 1,201,398
Series A redeemable, convertible preferred stock -- 3,125,000 -- 3,125,000
--------------- --------------- --------------- ---------------
Diluted 10,403,910 7,092,138 10,481,666 6,933,985
=============== =============== =============== ===============
Income per common share:
Basic $ 0.16 $ 0.36 $ 0.38 $ 0.49
=============== =============== =============== ===============
Diluted $ 0.14 $ 0.14 $ 0.32 $ 0.20
=============== =============== =============== ===============
</TABLE>
6
<PAGE> 7
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--PER SHARE INFORMATION (CONTINUED)
During the fiscal year ended March 31, 1999, NEON granted stock options at
prices considered below the then fair value of the underlying common stock. The
cumulative differential between the fair value of the underlying stock and the
exercise price of the granted options was $2.5 million, which is amortizable to
expense over the vesting period of the options. This deferred compensation
balance was reduced during the quarter ended December 31, 1999 by $321,000 due
to the cancellation of options associated with terminated employees. During the
three-month and nine-month periods ended December 31, 1999, $108,000 and
$381,000, respectively, were recognized as non-cash compensation expense. The
deferred balance of $1.0 million will be recognized over the remaining vesting
period, approximately three years, of the granted options. In the third quarter
of fiscal year 2000, $349,000 was recognized as non-cash compensation expense
related to performance-based options granted to a NEON executive.
For the three-month periods ended December 31, 1999 and 1998, 176,914 and
244,870 stock options, respectively, were not included in the computation of
diluted net income per share because the effect would be antidilutive. For the
nine-month periods ended December 31, 1999 and 1998, 44,259 and -0- stock
options, respectively, were excluded in the computation of diluted net income
per share.
NOTE 3--COMPREHENSIVE INCOME
During fiscal year 1999 NEON adopted Financial Accounting Standards Board
Statement No. 130 ("FASB 130"), "Reporting Comprehensive Income." FASB 130
established new rules for reporting and displaying comprehensive income and its
components; however, the adoption has no impact on NEON's net income or total
stockholders' equity. In addition to net income, "Comprehensive Income" includes
foreign translation adjustments and unrealized gains or losses on NEON's
available-for-sale securities which, prior to adoption of FASB 130, were
reported separately in stockholders' equity. The components of comprehensive
income, net of applicable tax, for the nine-month periods ended December 31,
1999 and 1998, are as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
----------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Net income $ 3,361,543 $ 1,289,053
Foreign currency translation gains (losses) (33,027) (14,442)
Unrealized loss on debt securities (21,134) --
--------------- ---------------
Total comprehensive income $ 3,307,382 $ 1,274,611
=============== ===============
</TABLE>
NOTE 4--CONTINGENCIES
A number of organizations, including New Era of Networks, Inc., are
utilizing the name "NEON," alone and in combination with other words, as a
trademark, a tradename or both. New Era of Networks is also a developer and
distributor of middleware and other software products. New Era of Networks has
used the acronym "NEON" in its business, is listed on the Nasdaq National Market
under the symbol "NEON" and has sought to obtain federal trademarks for products
and services whose names include the word "NEON." NEON is currently opposing in
the U.S. Patent and Trademark Office New Era of Networks' application to
trademark "NEONET." On December 24, 1998, New Era of Networks filed a complaint
against NEON in the United States District Court for the District of Colorado
seeking (1) a declaratory judgment that New Era of Networks' use of certain
trademarks, including "NEONET," does not infringe NEON's rights or constitute
unfair competition and (2) cancellation of NEON's federal trademark registration
for NEON. NEON has filed an Answer denying the material allegations of that
complaint. Discovery has been completed in the action. No trial date has been
set.
7
<PAGE> 8
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--CONTINGENCIES (CONTINUED)
On June 23, 1999, NEON sued New Era of Networks in Fort Bend County, Texas,
alleging that New Era of Networks' use of "NEON" was in violation of Texas law
concerning tradenames and trademarks. In this litigation, NEON seeks to enjoin
New Era of Networks from using "NEON" as its "nickname," its Nasdaq trading
symbol, or in any other manner that is likely to result in confusion in the
marketplace, or to dilute the meaning or value of NEON's name. NEON's claims are
based upon its prior and continuous use of "NEON" as its corporate name. NEON
believes that it has superior rights to use "NEON" and that New Era of Networks'
use of NEON is causing confusion in the marketplace. This and any other
litigation to enforce NEON's right to use the NEON name in NEON's business or to
prevent others from using the NEON name may be expensive and time-consuming, may
divert management resources and may not be adequate to protect NEON's business.
If NEON should lose any such litigation, it may have to change its name, which
also would be expensive and time-consuming and could adversely affect NEON's
business.
On October 29, 1999, NEON entered into an agreed settlement with BMC
Software of its lawsuit with BMC Software. BMC Software originally filed the
lawsuit in August 1995 in the District Court of Travis County, Texas, 200th
Judicial District, against Peregrine/Bridge Transfer Corporation, John J. Moores
and a group of employees of Peregrine/Bridge Transfer Corporation who were also
former employees of BMC Software. In the lawsuit, BMC Software had alleged
misappropriation and infringement of certain trade secrets, confidential
information and corporate opportunity, as well as breach of contract and
fiduciary relations by the named individuals. NEON, which is the exclusive
distributor of software products developed by Peregrine/Bridge Transfer
Corporation, had been named as a co-defendant in this lawsuit in December 1996.
The October 1999 settlement resolved claims by BMC Software relating to NEON's
and Peregrine/Bridge Transfer Corporation's title in and right to market the
products of Peregrine/Bridge Transfer Corporation that were the subject of the
lawsuit. Under the terms of the settlement, BMC Software paid $30 million to
parties other than NEON. In addition, the settlement does not obligate NEON or
any other co-defendant to make any present or future cash payment or
disgorgement or impose any restriction on the marketing and sale by NEON of its
or Peregrine/Bridge Transfer Corporation's products. NEON has been indemnified
for its costs and expenses in this lawsuit by Peregrine/Bridge Transfer
Corporation under the terms of its distributor agreement with Peregrine/Bridge
Transfer Corporation.
NEON is involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of any of these matters will not have a material adverse effect on
NEON's consolidated financial position, results of operations or liquidity.
NOTE 5--OPERATIONS BY GEOGRAPHIC LOCATION
The table below summarizes selected financial information with respect to
NEON's operations by geographic location.
<TABLE>
<CAPTION>
THREE MONTHS ENDED DECEMBER 31, NINE MONTHS ENDED DECEMBER 31,
---------------------------------- ----------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
North America $ 7,201,384 $ 4,678,165 $ 16,755,867 $ 10,983,078
Europe 1,717,345 1,171,791 4,307,993 2,851,768
--------------- --------------- --------------- ---------------
$ 8,918,729 $ 5,849,956 $ 21,063,860 $ 13,834,846
=============== =============== =============== ===============
Operating income (loss):
North America $ 1,856,443 $ 1,825,216 $ 4,773,805 $ 3,018,887
Europe (157,330) (293,321) (1,106,187) (874,159)
--------------- --------------- --------------- ---------------
$ 1,699,113 $ 1,531,895 $ 3,667,618 $ 2,144,728
=============== =============== =============== ===============
Identifiable assets:
North America $ 54,212,215 $ 7,509,083 $ 54,212,215 $ 7,509,083
Europe 4,218,668 2,393,126 4,218,668 2,393,126
--------------- --------------- --------------- ---------------
$ 58,430,883 $ 9,902,209 $ 58,430,883 $ 9,902,209
=============== =============== =============== ===============
</TABLE>
8
<PAGE> 9
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--MARKETABLE SECURITIES
NEON considers all highly liquid investments with a maturity of three months
or less to be cash equivalents.
NEON has evaluated its investment policies consistent with Financial
Accounting Standards Board Statement No. 115 ("FASB 115"), "Accounting for
Certain Investments in Debt and Equity Securities", and determined that its
investment securities are to be classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses reported in stockholders' equity under the caption "Accumulated
other comprehensive income (loss)". The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.
The following is a summary of marketable securities classified as
"available-for-sale" securities as required by FASB 115:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------
<S> <C>
Debt Securities:
Cost $ 8,189,964
Gross unrealized losses (21,134)
---------------
Estimated fair value $ 8,168,830
===============
</TABLE>
The amortized cost and estimated fair value based on published closing
prices of securities at December 31, 1999, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities because the
issuers of the securities may have the right to repay obligations without
prepayment penalties.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
---------------------------------------
ESTIMATED FAIR
COST VALUE
--------------- ---------------
<S> <C> <C>
Available-for-sale:
Due in one year or less $ 5,191,525 5,163,127
Due after one year through five years 2,998,439 3,005,703
</TABLE>
NOTE 7--ACQUISITIONS
On September 29, 1999, NEON completed its acquisition of assets from Beyond
Software Inc. The business, headquartered in Santa Clara, California, was
acquired for $1,870,000 in cash, plus the assumption of certain liabilities. The
acquisition resulted in goodwill of $2,385,294, which is being amortized on a
straight-line basis over five years. During the three months and nine months
ended December 31, 1999, $117,000 was recognized as non-cash amortization.
NOTE 8--OTHER ASSETS
In December 1999, NEON Beyond Acquisition Corporation entered into an
agreement with Sterling Software and certain of its affiliates ("Sterling") that
grants NEON certain rights to use, reproduce, copy and sell certain Sterling
products. NEON has made a nonrefundable advance to Sterling of $3.5 million as
consideration for future royalties to be earned by Sterling from sales of $14
million of such products by NEON. This amount has been included in "Other
Assets" on the accompanying balance sheet. Under the agreement with Sterling,
NEON also acquired an option to purchase the intellectual property underlying
such products at any time through December 30, 2000 for $1,000,000.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains certain forward-looking statements, as
that term is defined under federal securities laws, that involve inherent risks
and uncertainties. NEON's actual results and the timing of certain events could
differ materially from those discussed in the forward-looking statements as a
result of certain factors, including those set forth under the heading "Risk
Factors" in NEON's filings with the Securities and Exchange Commission,
including its Form 10-K for the fiscal year ended March 31, 1999. Additional
information concerning factors that could cause results to differ materially
from those forward-looking statements is contained under Item 5. "Other
Information." All forward-looking statements in this discussion are expressly
qualified in their entirety by the cautionary statements set forth below under
Item 5 and in NEON's Form 10-K and its subsequent filings with the Securities
and Exchange Commission.
RECENT EVENTS
On October 29, 1999, NEON entered into an agreed settlement with BMC
Software of its lawsuit with BMC Software. BMC Software originally filed the
lawsuit in August 1995 in the District Court of Travis County, Texas, 200th
Judicial District, against Peregrine/Bridge Transfer Corporation, John J. Moores
and a group of employees of Peregrine/Bridge Transfer Corporation who were also
former employees of BMC Software. In the lawsuit, BMC Software had alleged
misappropriation and infringement of certain trade secrets, confidential
information and corporate opportunity, as well as breach of contract and
fiduciary relations by the named individuals. NEON, which is the exclusive
distributor of software products developed by Peregrine/Bridge Transfer
Corporation, had been named as a co-defendant in this lawsuit in December 1996.
The October 1999 settlement resolved claims by BMC Software relating to NEON's
and Peregrine/Bridge Transfer Corporation's title in and right to market the
products of Peregrine/Bridge Transfer Corporation that were the subject of the
lawsuit. Under the terms of the settlement, BMC Software paid $30 million to
parties other than NEON. In addition, the settlement does not obligate NEON or
any other co-defendant to make any present or future cash payment or
disgorgement or impose any restriction on the marketing and sale by NEON of its
or Peregrine/Bridge Transfer Corporation's products. NEON has been indemnified
against its costs and expenses in this lawsuit by Peregrine/Bridge Transfer
Corporation under the terms of its distributor agreement with Peregrine/Bridge
Transfer Corporation.
In December 1999, NEON Beyond Acquisition Corporation entered into an agreement
with Sterling Software and certain of its affiliates ("Sterling") that grants
NEON certain rights to use, reproduce, copy and sell certain Sterling products.
NEON has made a nonrefundable advance to Sterling of $3.5 million as
consideration for future royalties to be earned by Sterling from sales of $14
million of such products by NEON. This amount has been included in "Other
Assets" on the accompanying balance sheet. Under the agreement with Sterling,
NEON also acquired an option to purchase the intellectual property underlying
such products at any time through December 30, 2000 for $1,000,000.
OVERVIEW
NEON develops, markets and supports Enterprise Access and Integration,
Security and Subsystem Management software for all industries. NEON was
incorporated in May 1993 and is a successor by merger to NEON Systems, Inc., an
Illinois corporation which was incorporated in June 1991. NEON introduced its
first generally available products, Shadow Direct and Shadow Web Server, in
November 1994 and January 1995, respectively. NEON introduced the third member
of the Shadow product line, Shadow Enterprise Direct, in February 1996. NEON's
Shadow products provide rapid and cost-effective access to and connectivity
10
<PAGE> 11
between enterprise data, transactions and applications. Shadow Direct enables
client/server applications to access and integrate with mainframe data and
applications. Shadow Enterprise Direct provides access and integration between
client/server systems. In addition, through its distributor agreement with
Peregrine/Bridge Transfer Corporation, NEON launched the first of its Enterprise
Subsystem Management products in January 1997. This product line, which
currently consists of seven products, improves the availability and performance
of mainframe subsystems to support the growing demands placed on the mainframe.
On May 3, 1999, NEON announced the release of its new enterprise security
management product, Halo SSO(TM).
NEON derives revenues exclusively from software licenses and maintenance
services. Historically, NEON's Shadow products have generated substantially all
of its revenues. License fees, which are based upon the number and capacity of
servers as well as the number of client users, are generally due upon license
grant and include a one-year maintenance period. The license sales process
typically takes three to nine months. After the initial year of license, NEON
provides ongoing maintenance services, including technical support and product
enhancements, for an annual fee based upon the current price of the products.
Since NEON's inception, over 95% of customers have elected to continue
maintenance service after the first year. Maintenance revenues are expected to
continue to increase as a percentage of total revenues as NEON's customer base
continues to grow.
NEON recognizes revenues in accordance with the American Institute of
Certified Public Accountants Statement of Position 97-2. NEON sells its products
under perpetual license and recognizes license revenues when all of the
following conditions are met: a non-cancelable license agreement has been
signed; the product has been delivered; there are no material uncertainties
regarding customer acceptance; collection of the receivable is probable; and no
other significant vendor obligation exists. Maintenance revenues are recognized
ratably over the maintenance service period, which is typically one year. The
portion of maintenance revenues that has not yet been recognized as revenue is
reported as deferred revenue on NEON's balance sheet.
NEON conducts its business in the United Kingdom and Germany through two
wholly-owned consolidated subsidiaries. Revenues from these subsidiaries are
denominated in local currencies. Pursuant to these foreign operations, NEON is
exposed to foreign currency fluctuations for its net working capital positions.
At December 31, 1999, NEON had unhedged net current assets denominated in
British pounds aggregating 1,455,725 British pounds and unhedged net current
liabilities denominated in deutschemarks aggregating 327,392 deutschemarks. At
that date, NEON had no material commitments that would be satisfied in
currencies other than U.S. dollars. In other international markets, NEON
conducts substantially all of its business through independent third-party
distributors. Revenues derived from third-party distributors are denominated in
U.S. dollars. Revenues recognized from sales to customers outside North America,
primarily in Europe, represented approximately 26% and 28%, respectively, of
total revenues in the three months ended December 31, 1999 and 1998,
respectively. In the nine months ended December 31, 1999 and 1998, revenues
recognized from sales to customers outside North America, primarily in Europe,
represented approximately 28% and 27%, respectively, of total revenues. The
British pound and the German mark have been relatively stable against the U.S.
dollar for the past several years. As a result, foreign currency fluctuations
have not had a significant impact on NEON's revenues or operating results.
Management does not currently have an active foreign exchange hedging program;
however, NEON may implement a program to mitigate foreign currency transaction
risk in the future. Although NEON's international operations and sales levels
are subject to economic, fiscal and monetary policy of foreign governments, to
date these factors have not had a material effect on NEON's results of
operations or liquidity. NEON expects that fiscal 2000 revenues from
international operations should not vary substantially as a percentage of total
revenue or from the level experienced in fiscal 1999.
11
<PAGE> 12
RESULTS OF OPERATIONS
The following table sets forth, for the periods illustrated, certain
statement of operations data expressed as a percentage of total revenues:
<TABLE>
<CAPTION>
THREE MONTHS ENDED DECEMBER 31, NINE MONTHS ENDED DECEMBER 31,
---------------------------------- ----------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
License 81% 78% 76% 76%
Maintenance 19 22 24 24
--- --- --- ---
Total revenues 100 100 100 100
Cost of revenues:
Cost of licenses 8 2 5 5
Cost of maintenance 6 5 6 5
--- --- --- ---
Total cost of revenues 14 7 11 10
--- --- --- ---
Gross profit 86 93 89 90
Operating expenses:
Sales and marketing 35 35 38 38
Research and development 16 18 18 20
General and administrative 10 11 12 12
Non-cash compensation 6 2 4 5
--- --- --- ---
Total operating expenses 67 67 72 75
--- --- --- ---
Operating income 19 26 17 16
Interest and other, net 6 1 8 --
--- --- --- ---
Income before provision for income 25 27 25 16
taxes
Provision for income taxes 9 10 9 6
--- --- --- ---
Net income 16% 17% 16% 10%
=== === === ===
</TABLE>
THREE MONTHS ENDED DECEMBER 31, 1999 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
1998
REVENUES
Total revenues. NEON's revenues increased $3.1 million or 52% from $5.8
million for the three months ended December 31, 1998 to $8.9 million for the
three months ended December 31, 1999. One customer accounted for 26% of total
revenues in the three months ended December 31, 1998; two customers each
individually accounted for 10% and two additional customers for 11% each of
total revenues in the three months ended December 31, 1999.
License. License revenues increased $2.7 million or 59% from $4.5 million
for the three months ended December 31, 1998 to $7.2 million for the three
months ended December 31, 1999. Approximately $1.4 million of this increase
resulted from increased license sales of NEON's Shadow products, with an
additional $1.3 million increase in sales of Enterprise Subsystem Management
products.
Maintenance. Maintenance revenues increased $389,000 or 30% from $1.3
million for the three months ended December 31, 1998 to $1.7 million for the
three months ended December 31, 1999. This increase resulted primarily from the
increase in NEON's cumulative installed base of customers.
12
<PAGE> 13
COST OF REVENUES
Cost of licenses. Cost of license revenues includes costs of product
licenses, such as product manuals, distribution and media costs for NEON's
software products, as well as royalty payments to third parties related to
license revenues primarily resulting from NEON's sales of Enterprise Subsystem
Management products. Cost of license revenues increased $560,000 or 416% from
$134,000, or 3% of license revenues, for the three months ended December 31,
1998 to $694,000, or 10% of license revenues, for the three months ended
December 31, 1999. The increase in the cost of license revenues was attributable
to additional royalties on increased shipments of Enterprise Subsystem
Management products sold by NEON under the terms of its distributor agreement
with Peregrine/Bridge Transfer Corporation.
Cost of maintenance. Cost of maintenance revenues includes personnel and
other costs related to NEON's customer support department. Cost of maintenance
revenues increased $274,000 or 104% from $265,000, or 20% of maintenance
revenues, for the three months ended December 31, 1998 to $539,000, or 32% of
maintenance revenues, for the three months ended December 31, 1999. The increase
was due principally to increased customer support costs in providing maintenance
services to NEON's growing installed customer base.
OPERATING EXPENSES
Sales and marketing. Sales and marketing expenses include salaries,
commissions, bonuses, benefits and travel expenses of sales, presales support
and marketing personnel, together with trade show participation and other
promotional expenses. These expenses increased on a dollar basis $1.0 million or
52% from $2.1 million, or 35% of total revenues, for the three months ended
December 31, 1998 to $3.1 million, or 35% of total revenues, for the three
months ended December 31, 1999. The dollar increase resulted primarily from a
$482,000 increase in compensation expenses incurred in the hiring of additional
North American sales personnel and the payment of increased sales commissions as
a result of NEON's revenue growth. In addition, the dollar increase includes
approximately $267,000 of increased commissions to NEON's independent
international agents. Increases in travel expenses and in international sales
support further contributed to the expenses.
Research and development. Research and development expenses include
salaries, bonuses and benefits to product authors, product developers and
product documentation personnel and the computer hardware, software and
telecommunication expenses associated with these personnel. NEON compensates
product authors based on a percentage of product license revenues generated by
products which they develop. Research and development expenses increased on a
dollar basis $337,000 or 32% from $1.0 million, or 18% of total revenues, for
the three months ended December 31, 1998 to $1.4 million, or 16% of total
revenues, for the three months ended December 31, 1999. The dollar increase
results primarily from a $304,000 increase in recruitment and compensation costs
due to increased staffing and, to a lesser extent, from increased product
commissions paid to product authors. Research and development expenses are
expected to increase in absolute dollar amounts but not vary substantially as a
percentage of total revenues from the level experienced in the three months
ended December 31, 1999. NEON has followed Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed" for the past several years. Research and
development expenditures in general have been charged to operations as incurred
and any amounts that were capitalizable have been immaterial.
13
<PAGE> 14
General and administrative. General and administrative expenses include
salaries, personnel and related costs for NEON's executive, financial, legal and
administrative staff. General and administrative expenses increased on a dollar
basis $224,000 or 34% from $665,000, or 11% of total revenues, for the three
months ended December 31, 1998 to $889,000, or 10% of total revenues, for the
three months ended December 31, 1999. This dollar increase resulted primarily
from a $78,000 increase in legal expenses, mostly associated with the litigation
with New Era of Networks (See Note 4 to the Financial Statements), and $79,000
of increased costs in the offices in Germany and the United Kingdom. NEON
anticipates that general and administrative expenses will continue to increase
in absolute dollars but should not vary substantially as a percentage of total
revenues from the level experienced in the three months ended December 31, 1999.
Non-cash compensation and amortization. During the twelve months prior to
NEON's initial public offering on March 5, 1999, NEON granted stock options at
prices subsequently considered below the then-fair value of the underlying
stock. The cumulative differential between the fair value of the underlying
stock and the exercise price of the granted options was $2.5 million, which is
amortizable to expense over the vesting period of the granted options. This
deferred compensation balance was reduced this quarter by $321,000 due to the
cancellation of options associated with terminated employees. During the three
months ended December 31, 1999, $108,000 was recognized as non-cash compensation
expense. The deferred balance of $1.0 million will be recognized over the
remaining vesting period, approximately three years, of the granted options.
Additionally, in the third quarter of fiscal year 2000, $349,000 was recognized
as non-cash compensation expense related to performance-based options granted to
a NEON executive.
On September 29, 1999, NEON completed its acquisition of the assets of
Beyond Software Inc. The acquisition resulted in goodwill of approximately $2.4
million, which is being amortized on a straight-line basis over five years.
Goodwill amortization of $117,000 was recognized in the three months ended
December 31, 1999.
Interest and other income, net. Interest income increased $563,000 from
$34,000 for the three months ended December 31, 1998 to $597,000 for the three
months ended December 31, 1999. This increase results from investment of the
increase in NEON's cash and cash equivalents and investments balances derived
primarily from the $41.2 million of net proceeds received from NEON's March 1999
initial public offering.
Provision for income taxes. NEON fully utilized its net operating loss
carryforward for U.S. income tax purposes in fiscal 1998. The effective income
tax rates were 38% and 37% for the three months ended December 31, 1998 and
1999, respectively.
NINE MONTHS ENDED DECEMBER 31, 1999 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
1998
REVENUES
Total revenues. NEON's revenues increased $7.3 million or 52% from $13.8
million for the nine months ended December 31, 1998 to $21.1 million for the
nine months ended December 31, 1999. One customer accounted for 16% of total
revenues in the nine months ended December 31, 1998; no customer accounted for
more than 10% of total revenues in the nine months ended December 31, 1999.
License. License revenues increased $5.5 million or 52% from $10.5 million
for the nine months ended December 31, 1998 to $16.0 million for the nine months
ended December 31, 1999. Approximately $3.9 million of this increase resulted
from increased license sales of NEON's Shadow products, while sales of
Enterprise Management Subsystem products increased $1.6 million.
14
<PAGE> 15
Maintenance. Maintenance revenues increased $1.7 million or 53% from $3.3
million for the nine months ended December 31, 1998 to $5.0 million for the nine
months ended December 31, 1999. This increase resulted primarily from increases
in NEON's cumulative installed base of customers.
COST OF REVENUES
Cost of licenses. Cost of license revenues includes costs of product
licenses, such as product manuals, distribution and media costs for NEON's
software products, as well as royalty payments to third parties related to
license revenues resulting primarily from NEON's sales of Enterprise Subsystem
Management products. Cost of license revenues increased $443,000, or 67% from
$662,000, or 6% of license revenues, for the nine months ended December 31, 1998
to $1.1 million or 7% of license revenues, for the nine months ended December
31, 1999. The increase in the cost of license revenues was attributable to
additional royalties on increased shipments of Enterprise Subsystem Management
products sold by NEON under the terms of its distributor agreement with
Peregrine/Bridge Transfer Corporation.
Cost of maintenance. Cost of maintenance revenues includes personnel and
other costs related to NEON's customer support department. Cost of maintenance
revenues increased $490,000, or 73% from $672,000, or 20% of maintenance
revenues, for the nine months ended December 31, 1998 to $1.2 million, or 23% of
maintenance revenues, for the nine months ended December 31, 1999. The dollar
increase was due principally to increased customer support costs in providing
maintenance services to NEON's growing installed customer base.
OPERATING EXPENSES
Sales and marketing. Sales and marketing expenses include salaries,
commissions, bonuses, benefits and travel expenses of sales, presales support
and marketing personnel, together with trade show participation and other
promotional expenses. These expenses increased on a dollar basis $2.6 million or
50% from $5.3 million, or 38% of total revenues, for the nine months ended
December 31, 1998 to $7.9 million, or 38% of total revenues, for the nine months
ended December 31, 1999. The dollar increase includes a $352,000 increase in
expenses related to NEON's sales offices in Germany and the United Kingdom, a
$1.2 million increase in additional compensation expenses incurred in the hiring
of additional North American sales personnel and the payment of increased sales
commissions as a result of NEON's revenue growth. In addition, the dollar
increase includes approximately $376,000 of increased commissions to NEON's
independent international agents and $247,000 of increased marketing and selling
expenses, principally due to increases in marketing efforts and a larger number
of sales and marketing staff.
Research and development. Research and development expenses include
salaries, bonuses and benefits to product authors, product developers and
product documentation personnel and the computer hardware, software and
telecommunication expenses associated with these personnel. NEON compensates
product authors based on a percentage of product license revenues generated by
products which they develop. Research and development expenses increased on a
dollar basis $1.1 million, or 39% from $2.7 million, or 20% of total revenues,
for the nine months ended December 31, 1998 to $3.8 million, or 18% of total
revenues, for the nine months ended December 31, 1999. The dollar increase
includes a $951,000 increase in recruitment and compensation costs due to
increased staffing, partially offset by decreased product commissions paid to
product authors. The dollar increase also includes increased operating expenses,
principally due to office and computer facilities required by a larger number of
research and development staff. NEON anticipates that it will continue to devote
substantial resources to product research and development for the foreseeable
future. Research and development expenses are expected to increase in absolute
dollar amounts but not vary substantially as a percentage of total revenues from
the level experienced in the nine months ended December 31, 1999. NEON has
followed Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed" for the
past several years. Research and development expenditures in general have been
charged to operations as incurred and any capitalizable amounts have been
immaterial.
15
<PAGE> 16
General and administrative. General and administrative expenses include
salaries, personnel and related costs for NEON's executive, financial, legal and
administrative staff. General and administrative expenses increased on a dollar
basis $862,000 or 51% from $1.7 million, or 12% of total revenues, for the nine
months ended December 31, 1998 to $2.6 million, or 12% of total revenues, for
the nine months ended December 31, 1999. This dollar increase resulted primarily
from a $444,000 increase in legal costs, primarily expenses associated with the
litigation with New Era of Networks. Additionally, NEON experienced increased
depreciation associated with additional furniture and computer equipment and
increases in costs associated with SEC reporting and stockholder services in
satisfaction of its obligations as a public company in fiscal 2000 that were not
applicable as a private company in fiscal 1999. The dollar increase also
includes increased operating expenses, principally due to office facilities
required by a larger number of general and administrative staff. NEON
anticipates that general and administrative expenses will continue to increase
in absolute dollars but should not vary substantially as a percentage of total
revenues from the level experienced in the nine months ended December 31, 1999.
Non-cash compensation and amortization. During the twelve months prior to
NEON's initial public offering on March 5, 1999, NEON granted stock options at
prices subsequently considered below the then-fair value of the underlying
stock. The cumulative differential between the fair value of the underlying
stock and the exercise price of the granted options was $2.5 million, which is
amortizable to expense over the vesting period of the options granted. This
deferred compensation balance was reduced during the quarter ended December 31,
1999 by $321,000 due to the cancellation of options associated with terminated
employees. During the nine months ended December 31, 1999, $381,000 was
recognized as non-cash compensation expense. The deferred balance of $1.0
million will be recognized over the remaining vesting period, approximately
three years, of the granted options. Additionally, in the third quarter of
fiscal year 2000, $349,000 was recognized as non-cash compensation expense
related to performance-based options granted to a NEON executive.
On September 29, 1999, NEON completed its acquisition of the assets of
Beyond Software Inc. The acquisition resulted in goodwill of approximately $2.4
million, which is being amortized on a straight-line basis over five years.
Goodwill amortization of $117,000 was recognized in the three months ended
December 31, 1999.
Interest and other income, net. Interest income increased $1.6 million from
$67,000 for the nine months ended December 31, 1998 to $1.7 million for the nine
months ended December 31, 1999. This increase resulted from investment of the
increase in NEON's cash and cash equivalents and investments balances derived
primarily from the $41.2 million of net proceeds received from NEON's March 1999
initial public offering.
Provision for income taxes. NEON fully utilized its net operating loss
carryforward for U.S. income tax purposes in fiscal 1998. The effective income
tax rates were 38% and 37% for the nine months ended December 31, 1998 and 1999,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
NEON's cash and cash equivalent balance decreased to $33.2 million at
December 31, 1999 from $45.4 million at March 31, 1999. This decrease was due
primarily to the investment of $8.2 million in marketable securities. Additional
cash requirements included the acquisition of assets from Beyond Software Inc.
in September 1999 and the $3.5 million royalty advance to Sterling in December
1999. These uses of cash were offset partially by profitable operating results.
Net cash provided by operating activities was $1.7 million in the nine
months ended December 31, 1998, compared to a net use of cash by operating
activities of $1.4 million in the nine months ended December 31, 1999. The
primary reason for this change is the December 1999 advance royalty payment to
Sterling of $3.5 million.
16
<PAGE> 17
A majority of NEON's revenues are recorded in the latter half of each
quarter. Accordingly, as NEON's quarterly revenues have increased, the aggregate
balance of accounts receivable-trade has also increased. Future increases in
NEON's accounts receivable-trade balance will reduce cash flows otherwise
available from NEON's operating results.
Net cash used by NEON in investing activities was $86,000 and $10.7 million
in the nine months ended December 31, 1998 and 1999, respectively. The sole
investment use in the nine months ended December 31, 1998 was purchases of
property and equipment, including computer hardware and software to support
NEON's growing employee base. Purchases of both short-term and long-term
marketable securities and the acquisition of assets of Beyond Software Inc. were
the principal uses of investing funds in the nine months ended December 31,
1999. As of December 31, 1999, NEON had no material commitment for capital
expenditures.
NEON's net cash provided by (used in) financing activities was $144,000 and
($54,000) in the nine months ended December 31, 1998 and 1999, respectively. Net
cash provided by financing activities in the period ending December 31, 1998 was
solely from amounts received from the exercise of employee stock options. For
the nine months ended December 31, 1999, amounts received from the exercise of
employee stock options were more than offset by the cost of shares repurchased
by NEON in settlement of payroll tax obligations of employees related to the
exercises of these stock options.
NEON believes that its current balances of cash and investments in
highly-liquid marketable investment securities as well as cash provided by
future operations will be sufficient to meet its working capital and anticipated
capital expenditure requirements for at least the next 12 months. Thereafter,
NEON may require additional funds to support its working capital requirements or
for other purposes and may seek to raise such additional funds through public or
private equity financing or from other sources. There can be no assurance that
additional financing will be available at all, or if available, that such
financing will be obtainable on terms acceptable to NEON or that any additional
financing will not be dilutive to existing stockholders.
YEAR 2000 ISSUES
Background and assessment. Some computers, software and other equipment
include programming code in which calendar year data is abbreviated to only two
digits. As a result of this design decision, there was widespread concern prior
to January 1, 2000 that some of these systems could fail to operate or fail to
produce correct results if "00" was interpreted to mean 1900, rather than 2000.
These problems have been commonly referred to as the Year 2000 Problem.
Present Year 2000 status. Even though the date is now past January 1, 2000,
and NEON has not experienced any immediate adverse impact from the transition to
the Year 2000, it cannot provide any assurance that its suppliers and customers
have not been affected in a manner that is not yet apparent. In addition,
certain computer programs that were date sensitive to the Year 2000 may not
have been programmed to process the Year 2000 as a leap year, and any
consequential negative effects remain unknown. As a result, NEON will continue
to monitor its Year 2000 compliance and the Year 2000 compliance of its
suppliers and customers and remain alert to any Year 2000 Problem that may
arise.
17
<PAGE> 18
In assessing the effect of the Year 2000 Problem on NEON, management
determined that there existed three general areas that needed to be evaluated:
o Software products sold to customers
o Internal infrastructure
o Supplier/third party relationships
A discussion of the various activities related to assessment and actions
resulting from those evaluations is set forth below.
Software products sold to customers. Several years ago, NEON initiated and
completed a recoding of its software products that made them Year 2000
compliant. All earlier versions of the software products previously delivered to
customers were replaced with those recoded products. Subsequently developed
products were tested for Year 2000 compliance. All of NEON's products were
tested for Year 2000 compliance. However, once licensed, NEON's products
interact with other non-NEON developed products and operate on computer systems
that are not under NEON's control, and these factors could affect the
performance of NEON's products if a Year 2000 Problem existed in a different
facet of a customer's information technology infrastructure. Prior to December
31, 1999, NEON did not assess the existence of these potential problems in its
customers' various environments. The development of Year 2000 compliant products
did not cause a significant increase in the development costs of NEON's software
products. To date, NEON has not identified any failure of its products to be
Year 2000 compliant or any Year 2000 Problems as a result of interaction with
non-NEON developed products.
Internal Infrastructure. Prior to December 31, 1999, NEON completed
examining and verifying that all of its personal computers, servers and software
were Year 2000 compliant. NEON completed the process of replacing or upgrading
all items noted that were not Year 2000 compliant. NEON researched and found
that the vendors of all of its critical applications had represented that their
products were Year 2000 compliant. NEON completed upgrading its financial and
accounting software prior to December 31, 1999. This upgrade involved purchasing
an upgraded version of its existing financial and accounting software package
that the vendor certified to be free of Year 2000 Problems. The costs related to
these efforts were not material to NEON's business, financial condition or
results of operations.
NEON did not utilize the resources of third parties to assess and/or
validate the reliability of its Year 2000 Problem, and its assessment and
corrections of the Year 2000 Problem did not cause the deferment of information
technology-related projects.
Suppliers/third party relationships. Prior to December 31, 1999, NEON
gathered information from vendor Websites and available compliance statements
and initiated communications with third-party suppliers of the major computers,
software and other equipment used, operated or maintained by NEON to identify
and, to the extent possible, resolve issues involving the Year 2000 Problem.
NEON relies on outside vendors for water, electrical and telecommunications
services as well as climate control, building access and other infrastructure
services. To date, NEON has not experienced any delays or interruptions in its
services; however, any failure of these third parties to resolve Year 2000
problems with their systems could have a material adverse effect on NEON's
business, financial condition or results of operations.
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<PAGE> 19
Strain on customers' information technology resources. Some organizations'
systems may have been seriously disrupted as a result of the Year 2000 Problem.
As a result, their attention and capital expenditures could shift away from the
need for applications addressed by NEON's products to capital expenditures
required to resolve any Year 2000 Problems experienced by such organizations.
Contingency Plans. By the end of the third quarter of fiscal 2000, NEON had
developed contingency plans to be implemented as part of its efforts to identify
and correct Year 2000 Problems affecting its internal systems. These plans
included accelerated replacement of affected equipment or software; short to
medium-term use of back-up equipment and software; increased work hours for NEON
personnel or use of contract personnel to correct, on an accelerated schedule,
any Year 2000 Problems which arise or to provide manual workarounds for
information systems; and other similar approaches. To date, NEON has not
implemented any of its contingency plans; however, if NEON is required to
implement any of these contingency plans in the future, such plans could have a
material adverse effect on NEON's business, financial conditions or results of
operations.
To date, NEON has incurred less than $50,000 in expenses relating to
identification and correction of Year 2000 Problems, and NEON does not expect to
incur any material additional expenses for such activities in fiscal year 2000.
Based on the actions NEON has taken as discussed above and the lack of any
Year 2000 Problems to date, NEON believes that it has identified and resolved
all Year 2000 Problems that could materially adversely affect its business and
operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
NEON is exposed to a variety of risks, including foreign currency exchange
rate fluctuations and changes in the market value of its investments. In seeking
to minimize the risks and/or costs associated with such activities, NEON manages
exposure to change in interest rates and foreign currency exchange rates.
The majority of NEON's foreign currency transactions are denominated in
British pound sterling, which is the functional currency of NEON Systems (UK)
Ltd. As sales contracts are denominated and settled in the functional currency,
risks associated with currency fluctuations are minimized to foreign currency
translation adjustments. NEON does not currently hedge against foreign currency
translation risks and believes that foreign currency exchange risk is not
significant to its operations.
NEON adheres to a conservative investment policy, whereby its principal
concern is the preservation of liquid funds while maximizing its yield on such
assets. Cash and cash equivalents approximated $33.2 million at December 31,
1999 and were invested in varying types of money market securities. An
additional $5.2 million was invested in short-term available-for-sale marketable
securities with maturity dates from three months to one year in term, and $3.0
million was invested in available-for-sale marketable securities with maturity
dates beyond one year. NEON believes that a near-term change in interest rates
would not materially affect its financial position, results of operations or net
cash flows for fiscal year 2000.
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<PAGE> 20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS - Please see the discussion in Part I, Item 2.
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" under the caption "Contingencies."
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS - In March 1999, NEON
completed the initial public offering of its common stock (the "IPO").
The Securities and Exchange Commission declared the Registration
Statement (File No. 333-69651) relating to the IPO effective on March 4,
1999. In the IPO, NEON issued and sold 3,041,000 shares for an aggregate
price to the public of $45,615,000, and a sole selling stockholder sold
64,000 shares of common stock for an aggregate offering price of
$960,000. The IPO was a firm commitment underwriting, and the managing
underwriters of the IPO were Donaldson, Lufkin & Jenrette Securities
Corporation, Hambrecht & Quist LLC and CIBC Oppenheimer Corp. The
underwriting discount incurred by NEON relating to the IPO was
$3,193,050. Net offering proceeds received by NEON from the IPO were
approximately $41.2 million. Approximately $1.0 million of the proceeds
received by NEON from the IPO was used to repay existing indebtedness
and $1.9 million was used in connection with the acquisition of the
assets of Beyond Software Inc. Additionally, approximately $3.5 million
in royalties was advanced to Sterling Software in December 1999. The
remainder of the proceeds from the IPO (other than the proceeds used to
repay the existing indebtedness and other uses described in Part I, Item
2, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" under the caption "Liquidity and Capital
Resources") were invested in interesting-bearing, investment-grade
securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS- Not Applicable
ITEM 5. OTHER INFORMATION - RISKS ASSOCIATED WITH FORWARD-LOOKING STATEMENTS -
This filing contains certain forward-looking statements such as NEON's
or management's intentions, hopes, beliefs, expectations, strategies,
predictions or any other variations thereof or comparable phraseologies
of NEON's future activities or other future events or conditions within
the meaning of Section 27A of the Securities Act and Section 21E of the
Securities Exchange Act of 1934, as amended, which are intended to be
covered by the safe harbors created thereby. Investors are cautioned
that all forward-looking statements involve risks and uncertainty.
Although NEON presently believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and, therefore, there can be no
assurance that the forward-looking statements included in this filing
will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the
inclusion of such information should not be regarded as a representation
by NEON or any other person that the objectives and plans of NEON will
be achieved.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 - Financial Data Schedule
(b) REPORTS ON FORM 8-K - NEON did not file any reports on Form 8-K
during the third quarter of its fiscal year 2000, which was the quarter
for which this report is filed.
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
NEON SYSTEMS, INC.
February 11, 2000 /s/ JOE BACKER
----------------------------------------
Joe Backer
President and Chief Executive Officer
(Principal executive officer)
February 11, 2000 /s/ JOHN REILAND
----------------------------------------
John S. Reiland
Chief Financial Officer
(Chief accounting officer)
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
--- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 33,223,237
<SECURITIES> 5,163,127
<RECEIVABLES> 8,657,155
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 48,512,727
<PP&E> 1,789,215
<DEPRECIATION> 678,449
<TOTAL-ASSETS> 58,430,883
<CURRENT-LIABILITIES> 8,966,462
<BONDS> 0
0
0
<COMMON> 89,714
<OTHER-SE> 49,374,707
<TOTAL-LIABILITY-AND-EQUITY> 58,430,883
<SALES> 0
<TOTAL-REVENUES> 21,063,860
<CGS> 0
<TOTAL-COSTS> 2,266,402
<OTHER-EXPENSES> 15,129,840
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,797
<INCOME-PRETAX> 5,335,782
<INCOME-TAX> 1,974,239
<INCOME-CONTINUING> 3,361,543
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,361,543
<EPS-BASIC> 0.38
<EPS-DILUTED> 0.32
</TABLE>
